Haircut
The percentage cut applied to the market value of collateral before it counts towards margin, so that a fall in its price does not leave the clearing corporation or broker under-covered.
In plain language
If you give a pawnbroker a gold chain worth Rs 1 lakh, he will not lend you Rs 1 lakh against it. He lends less, because gold prices move and selling takes time. The gap is his safety margin.
A haircut is the same idea in the securities market. When a member deposits collateral with a clearing corporation, or a client gives collateral to a broker, its market value is reduced by a set percentage before it counts. Cash has no haircut. Riskier or less liquid assets have bigger ones.
How it works
Haircuts on clearing members' liquid assets (Chapter 4, section 4.1.1.2, Table 4.2)
| Collateral | Haircut |
|---|---|
| Cash, bank FDs, bank guarantees | 0 |
| Central Government securities | Based on the liquidity and tenor of the security |
| Growth-plan units of overnight MF schemes | 5% |
| Other overnight MF units, liquid MF units, gilt MF units | 10% |
| Liquid equity shares (impact cost up to 0.1%, traded on at least 99% of days) | VaR based on 6 sigma, minimum 9% |
| Other MF units | VaR based on 6 sigma, minimum 9% |
| Corporate bonds | Fixed or VaR-based, minimum 10%; can be higher to cover the time needed to liquidate |
Liquid assets are valued daily after applying the haircuts.
Haircuts in margin trading (Chapter 8)
- A client's initial margin for MTF can be paid in cash, cash equivalents or Group I shares and equity ETF units, "with appropriate haircut".
- For equity ETF units used as MTF collateral, the haircut applicable to liquid (Group I) equity shares in the "other liquid assets" category applies.
- If collateral rises in value, the broker may grant further exposure subject to applicable haircuts, but no extra exposure is allowed on a rise in the value of funded stocks.
A different use of the word. In the default waterfall (Chapter 4, section 4.3.3), the last resort is a "pro-rata haircut to pay-outs". There the haircut is a proportional cut to what non-defaulting members receive, not a collateral valuation.
The formula
Value after haircut = Market value × (1 − Haircut %)
A worked example
Market values and the 11% equity VaR are illustrative; the other haircut rates are the workbook's.
A clearing member deposits four kinds of collateral, each with a market value of Rs 10,00,000:
| Collateral | Haircut | Calculation | Counts as |
|---|---|---|---|
| Growth units, overnight fund | 5% | 10,00,000 × 0.95 | Rs 9,50,000 |
| Liquid fund units | 10% | 10,00,000 × 0.90 | Rs 9,00,000 |
| Liquid equity shares (VaR 11%, above the 9% floor) | 11% | 10,00,000 × 0.89 | Rs 8,90,000 |
| Corporate bonds (minimum) | 10% | 10,00,000 × 0.90 | Rs 9,00,000 |
Total market value Rs 40,00,000; total value after haircuts = 9,50,000 + 9,00,000 + 8,90,000 + 9,00,000 = Rs 36,40,000.
If the equity VaR had been only 7%, the haircut would still be 9%, because 9% is the minimum: 10,00,000 × 0.91 = Rs 9,10,000.
Why NISM asks about it
Haircuts appear in Chapter 4 (section 4.1.1.2, Table 4.2 of acceptable liquid assets; section 4.3.3, pro-rata haircut to pay-outs in the default waterfall) and Chapter 8 (margin trading facility collateral and ETF units). The exam asks for specific rates (0, 5%, 10%, 9% minimum, 10% minimum) and asks you to compute collateral value after haircut.
Common exam traps
- Cash, FDs and bank guarantees: zero haircut.
- 5% only for growth-plan overnight fund units. Other overnight, liquid and gilt fund units take 10%.
- Minimums are floors. Equity takes the higher of its 6-sigma VaR and 9%; corporate bonds take at least 10%.
- G-sec haircuts depend on liquidity and tenor; the table gives no fixed figure.
- A haircut is not a margin. It reduces the value of what you deposit; margins are what you owe.
- "Pro-rata haircut to pay-outs" in the default waterfall is a loss-sharing step, not a collateral haircut.
Where this is taught
- Series XV · Chapter 7: Company Analysis – Business and Governanceintroduced here
- Series VII · Chapter 4: Risk Managementintroduced here
Related terms
- Value at RiskA statistical estimate of the most a position is likely to lose over a set holding period at a chosen confidence level — the idea behind the initial margin a clearing corporation charges on a derivatives trade.
- Default waterfallThe fixed order in which a clearing corporation uses its resources to cover a member default: defaulter's money first, then insurance, its own capital, the Core SGF, and last a haircut to pay-outs.
- Liquid assetsThe collateral a clearing member deposits with the clearing corporation, valued daily after haircuts, which must cover MTM losses, VaR margin, extreme loss margin and base minimum capital.
- Liquid Net WorthThe part of a merchant banker's net worth deployed in unencumbered liquid assets, counted after a prescribed haircut on each asset type — a second capital test that net worth alone cannot satisfy.
- Margin trading facilityA SEBI-regulated facility in which a stock broker lends part of the purchase price of eligible shares or equity ETFs to a client, holds the bought stock as pledged collateral and charges interest.
- Funded stocksShares or equity ETF units bought using money borrowed under margin trading, held only by pledge in a dedicated demat account and margined more heavily than the collateral backing the same facility.